GLOBAL REWARDS

Bill BarnhartCHICAGO TRIBUNE

The world was a friendly place for mutual fund investors this spring.

With the exception of gold funds, which desperately are searching for a rationale in today's investment climate, and funds invested in a few places, such as Thailand and Czechoslovakia, the robust returns recorded in the U.S. market were imitated and in some cases exceeded elsewhere.

According to Morningstar, the Chicago-based mutual fund research firm, international equity funds gained an average of 9.8 percent in the second quarter, well behind the 16.8 percent return for domestic growth equity funds.

Although the overall comparison makes the U.S. market the hands-down winner, several categories of international funds outpaced U.S. equities. Japan and Latin America, for example, enjoyed an impressive turnaround: up 19 percent.

According to Lipper Analytical Services, a New York-based mutual fund tracking service, Latin American equity funds were the big winner in the last 12 months, up 40 percent from the first half of 1996, nearly double the 22 percent gain for domestic equity funds.

Stock markets in Mexico, Germany, England and Canada, as well as the United States, are at or near record highs.

"Some of the changes that have occurred in America over the last 10 years in terms of companies focusing on earning money for shareholders are finally starting to happen in overseas markets," said David Herro, manager of the Chicago-based Oakmark International Fund. "We're starting to see it in Germany and France--almost unbelievably so, given the culture there--and very slowly in Japan."

"People running corporations now realize they are operating in a global market and are not protected by false borders," said Dennis Ferro, London-based manager of the Kemper International Fund.

Herro noted that the lag in international-fund performance, compared with the United States, relates in part to the strength of the dollar this spring in foreign-exchange markets. A strong dollar means that investment returns in non-U.S. markets are diluted when translated back into dollars. On Friday, the dollar hit a nearly six-year high against the German mark.

The convergence of positive market trends around the world seems like unvarnished good news--the kind that many mutual fund investors have come blithely to expect. But there could be a dark cloud ahead.

It's not just a matter of being a contrarian--the investor who hunts for bargains and bets against the conventional wisdom. It's also a matter of achieving portfolio diversification to insulate a long-term investment program from market shocks.

If world economies and world financial markets are converging toward common market-driven disciplines--with thousands of MBA replicates managing corporate and government affairs in like fashion around the globe--an investment portfolio, like an improperly bred strain of wheat or cows, becomes more vulnerable to disease. A portfolio fully correlated, marching in lockstep, is a weak portfolio.

Market analysts who study big-picture trends acknowledge in theory the risk posed by closer correlations among world economies and financial markets, but they see no evidence of an imminent threat.

Gary Brinson, of the Chicago-based global investment management firm Brinson Partners, said there is no doubt that, on a day-to-day basis, big moves in the U.S. financial markets ripple in the same direction through markets around the globe.

"But if we step away from the daily data and look at monthly or quarterly data over five, 10 or 15 years, the correlations are pretty low," he said. Granted, the correlations aren't negative--it was hard to find markets that regularly move opposite to the U.S. market, Brinson said. But "using those investment horizons, we find no evidence that correlations are increasing."

Correlations of stock price trends among diverse industries and companies within the U.S. market are much higher than among global markets.

"Certainly, the international equity markets do not move completely independent from one another, but the correlations among these markets are a lot lower than correlations among sectors of the U.S. markets," said Mark Riepe, a vice president at Chicago-based investment research firm Ibbotson Associates.

His company's data show that during the seven periods of at least a 10 percent decline in the Standard & Poor's 500 index since 1970, a diversified portfolio of international stocks declined less. For example, from June to October 1990, the S&P index dropped 14.7 percent and the Morgan Stanley index of major non-U.S.markets called EAFE (Europe/Australia/Far East) fell just 9.6 percent.

More recently, when U.S. stock prices were falling in March, the EAFE index rose in dollar terms.

Riepe believes the notion of homogenized economies and financial markets can be overstated. The world economies likely will become more integrated but not necessarily more alike, he said.

"It makes sense that economies will start to specialize in those areas where they have comparative advantages," he said. Countries could become the equivalent of industry sector funds, he said.

Nearly everyone foresees further eradication of trade barriers and expansion of integrated global financial markets. But it's unclear whether that process will produce more correlations among international asset prices.

Japan and the United States have highly integrated economies and financial markets. Trends in Japanese export production and pricing directly affect the U.S. economy. Japanese investments in U.S. Treasury bonds have helped keep U.S. interest rates low. Yet stock prices in Japan and the United States have diverged sharply for most of the 1990s, with the U.S. up and Japan down.

Brinson believes that the world is headed for a unified economic structure, where the headquarters city of a company will make little difference to investors. For example, most of Coca-Cola's profits are generated outside the United States. And most of the profits of Nokia, the Finland-based maker of communications equipment, are generated in the United States.

He agrees that many U.S. multinational companies, such as Coca-Cola, already deliver global investment returns to U.S. investors. "But why limit yourself?" he asks. It's like a steak without salt and pepper, seasoning a portfolio, he said.

In the first five months of this year, 16 percent of net new cash flowing into equity mutual funds was for international funds, up from 14 percent in the first five months of 1996.

Not a groundswell, but enough to attract the mutual fund industry's attention.

The hunt for investment opportunities and portfolio diversifiers is taking many people to mutual funds investing in the emerging markets of Latin America, Asia, Central Europe and Africa--one of the categories least correlated with the U.S. market.

At the same time, the demand from emerging countries for the world's capital is booming. Emerging markets represent 14 percent of global market capitalization, up from 4 percent 10 years ago.

Mark Mobius, globe-trotting manager of emerging-market equities for Franklin Templeton Funds, told a Morningstar conference in Chicago last month: "There's a lot of talk that this fad is over . . . but the answer is no. The number of privatizations taking place around the world in emerging markets is skyrocketing."

Robert Adler of AMG Data Services, which tracks money flows into and out of mutual funds, says despite the relatively low amounts of total assets in emerging-country funds, a third of the international funds he tracks are focused on the emerging-market category.

The flow of money into and out of international equity funds tends to be more volatile over time than flows into and out of domestic equity funds.

That's because mutual fund investors are more tenuous in their adventures into international investing, and many simply chase the latest fad.

Whether international investing will develop a widespread and permanent role as a portfolio diversification tool, rather than just an occasional gamble on a hot trend, remains to be seen.

Peter Jankovskis, international investment manager for ANB Investments in Chicago, said a key to utilizing international funds as a diversification tool is to select funds that do not attempt to hedge currency risk.

"You do not want to hedge out of the currency of the country," he said. Currency fluctuations are a principal factor in the lack of correlation among international markets, he said.